The Budgeting Two-Step

It was never my intention to mix finance and religion. But I got drafted – 26 years ago when the pillars of my local church discovered that they had a practicing CFO among their parishioners. So it has come to pass that ever since then I have been a member of a kaleidoscope of good people known colloquially as The FinCom.

For most of the quarter-century, our financial challenges have been relatively routine, with no schisms, no blown-up boilers, and two successful capital campaigns. We budget expenses in the context of revenue pledged by members before the start of the year, and we project a modest annual increase in receipts from our various annual fund-raising events. As the year progresses, none of the volunteer program chairpersons wants to be in a position of having overspent his or her budget, so invariably we come in below budget on overall expenses, producing a surplus that has accumulated nicely over the years.

However, we have left opportunities on the table – unfunded initiatives that could have provided outreach and benefit to the larger community over those years, perhaps even accelerating our slow-but-steady membership growth. No one has ever accused us of being too conservative, because everyone took comfort in the cumulative reserve, but we needed to figure out how to do more with our money.

The solution? Budgeting by the month. Not that we sit down and re-create the budget every month – we are just a church, and a fairly small one at that. Rather, in developing our budget this year, we traced the monthly flow of revenues and expenses for the past several years. We accounted not only for seasonality (those pledge receipts sure do go up in December) but for expenses such as insurance that hit our cash-basis books just a couple of times a year. At the end of any given month, we know where we are vs. where we thought we would be, and we can anticipate early-on a surplus or deficit. As a result, we can retool our strategy at any point in the year.

Pretty straightforward, right?

And yet an impressive array of smaller companies, as well as non-profits, track their monthly financial results against only their twelve- month budget. Four months into their fiscal year, if they’ve spent less than a third of their annual budgeted expense, they’re happy. No matter that historically three or four of their largest expenses blindside the budget in the fourth quarter.

Budget management is a twelve-month exercise – that is, you plan for each of the twelve months independently. And it’s also a twelve-month process, which requires you to work on it during all twelve months of the year. After the strategy and goal-setting discussions, the first operational step – the step backis always to review the ebbs and flows in revenues and expenses during the past year, most conveniently arrayed in a twelve-month spreadsheet, line item by line item. The efficient financial manager, true to his or her roots as the keeper of the company’s financial history, will have annotated with cellular comments each significant variance in revenue and expense. This allows you to head off a budget review discussion with your operating managers which otherwise goes something like this…

Finance: These are your expenses versus budget for the past year in the accounts you’re responsible for. Collectively, you’re over budget by almost 10%.

Operations: No way. You must be including stuff that belongs toR & D, or maybe even Marketing.

…and, unfortunately, inevitably ends up like this…

Finance: We have to recoup that 10% by reducing your other expenses going forward.

Operations: You might have given me a head’s up about this in month one, or at least at the end of the first quarter!

For many expenses, for example office supplies, the best monthly estimate is simply the annual budget divided by 12, unless you’re ramping up with new hires during the year. In other areas – e.g. utilities – you may want to allocate the annual total based on the pattern of the previous year. In a third instance, payroll taxes, you should be aware that unemployment taxes are levied on the first $14,000 (Massachusetts) and $7,000 (Federal) of employee earnings each year, so SUTA/FUTA expense will be significantly higher in the first calendar quarter than during the rest of the year.

With your budget-by-month well in hand, four short steps forward (okay, it’s not a two-step) will produce a timely “present view” of your likely year-end financial outcome:

  1. Next to the most recent month’s budget, insert a spreadsheet column with the actual results;
  1. Compare the two line by line, identifying the major variances, then documenting them in cellular comments;
  1. Update the budgeted numbers with your best estimate of revenues and expenses for the next two or three months, where you have visibility, never losing track of the original total budget in the far right-hand column of the spreadsheet.
  1. Add the columns of year-to-date actual results to those going forward containing your projections in order to produce a “Present View” of the most likely bottom line at year-end.

After each update, you’ll have an increasingly good idea what to expect at the end of the year on your current path compared to what you anticipated in the budget. If the variance is unfavorable, rework step three, adjusting and controlling expenses until you’re back in balance. If, on the other hand, you’re achieving a growing surplus, as indicated in the sidebar below, it may be time to do the two-step forward, revisiting your strategy and investing in new opportunities. But that’s a dance for another day…

Alligator Bites

“New data show that small businesses have battened down the hatches in response to the recession.

“From the beginning of this year through Sept 30, sales at small businesses (privately held companies with revenue of $10 million or less) have fallen 3.75 percent, according to figures from Sageworks Inc. At the same time, net profit at these businesses has risen to 6.5 percent [from 5.3% in 2008]. How have they accomplished this? By cutting their costs. Overhead, payroll and advertising as a percentage of sales have all declined.

“The numbers show that small companies have ‘reacted strongly and appropriately’ to survive the downturn, said Drew B. White, the chief financial officer of Sageworks.

“When you are a small business and your survival is at stake, it is hard to take financial and strategic risks, which generally require extra spending.

“‘I am not looking to privately held small business to lead us out of this recession,’ Mr. White said.”

The New York Times, November 8, 2009

Draining the Swamp

Percentage after five years by which the pay of U.S. workers laid off in a recession lags that of those who kept their jobs: 30

Percentage after twenty years: 20

Chance that such a worker will ever regain his or her income level: 1 in 4

Harper’s Index, November 2009 Source: Till von Wachter, Columbia University (NYC)